FPIs have begun to withdraw from the Indian markets. These FPIs were sellers in financial and IT services and buyers in telecom and capital goods.
Valuation Loss: The valuation loss, reflecting the appreciation of the US dollar against major currencies and the decline in gold prices also played a part in the decrease in foreign exchange reserves.
About 67% of the decline in reserves during the current financial year was due to valuation changes arising from an appreciating US dollar and higher US bond yields.
What are the Factors Affecting Exchange Rates?
Inflation Rates: Changes in market inflation cause changes in currency exchange rates. For e.g., a country with a lower inflation rate than another will see an appreciation in the value of its currency.
Balance of Payments: It consists of a total number of transactions including exports, imports, debt, etc.
A deficit in the current account due to spending more of its Forex on importing products than it is earning through the sale of exports causes depreciation, and it further fluctuates the exchange rate of its domestic currency.
Government Debt: Government debt is a debt owned by the central government. A country with large government debt is less likely to acquire foreign capital, leading to inflation.
In this case, foreign investors will sell their bonds in the open market if the market predicts government debt within a certain country. As a result, a decrease in the value of its exchange rate will follow.
UPSC Civil Services Examination Previous Year Question (PYQ)
Q. With reference to Balance of Payments, which of the following constitutes/constitute the Current Account? (2014)
Balance of trade
Balance of invisibles
Special Drawing Rights
Select the correct answer using the code given below:
(a) 1 only (b) 2 and 3 (c) 1 and 3 (d) 1, 2 and 4
The Balance of Payments (BoP) is composed of two main aspects: Current Account and Capital Account.
The Current Account of BoP measures the inflow and outflow of goods, services, investment incomes and transfer payments. Trade in services (invisibles); trade in goods (visibles); unilateral transfers; remittances from abroad; and international aid are some of the main components of the Current Account. When all the goods and services are combined, together they make up the Balance of Trade (BoT) of a country. Hence, 1 and 3 are correct.
Capital Account of BoP records all those transactions, between the residents of a country and the rest of the world, which cause a change in the assets or liabilities of the residents of the country or its government.
Loans and borrowing by private or public sectors; investments; and changes in the forex reserves are some of the examples of the components of the Capital Account. Hence, 2 and 4 are not correct. Therefore, option (c) is the correct answer.
Q. Justify the need for FDI for the development of the Indian economy. Why there is gap between MoUs signed and actual FDIs? Suggest remedial steps to be taken for increasing actual FDIs in India. (2016)